Public Bill Committee

[Mr. Jim Hood in the Chair]

(Except Clauses 7, 8, 9, 11, 14, 16, 20 and 92) - Clause 62

Sale of lessor companies etc: anti-avoidance

Question proposed,That the clause stand part of the Bill.

Jimmy Hood: With this it will be convenient to discuss the following: that schedule 31 be the Thirty-first schedule to the Bill.

Greg Hands: I begin by welcoming you back to the Chair for this afternoons sitting, Mr. Hood.
We are in the middle of a set of clauses that relate to anti-avoidance, with another three to go. Clause 62 and schedule 31 are anti-avoidance measures, designed to prevent the creation of leases that only ever make losses.
Anti-avoidance provisions were introduced in schedule 10 to the Finance Act 2006 in relation to changes in the ownership of companies carrying on a leasing business. Before that legislation was passed, a tax advantage could arise when a lessor company was sold to a group that expected to have tax losses available for surrender by way of group relief. The 2006 Act made provision to target changes in the economic ownership of a plant or machinery leasing business carried on by a company on its own or in partnership. That legislation applies to simple sales of shares in a leasing company and to changes in partnership sharing arrangements, in addition to any other route by which the economic ownership of a business could be changed.
The legislation aims to prevent an unacceptable permanent deferral of tax. It was previously possible for a leasing company to generate losses in the early years of a long leasing contract as a consequence of the availability of capital allowances, with such losses being available for group relief. In the later years of the lease, the capital allowances would be reduced and the company would become profitable. If the leasing company was sold in the interim to a loss-making company or group, the leasing companys profits would be covered by the new owners losses. Thus, an acceptable temporary deferral of tax became a permanent deferral of tax.
The tax advantage arose because the tax relief available via capital allowances normally exceeds the commercial depreciation at the outset of a lease. The timing advantage reverses later in the lease period. The effect of the accelerated capital allowances is that a lessor company will often realise tax losses to begin with, which will be available for surrender by way of group relief. Therefore, the sale of lease-tails, when a lessor company is sold to a group with tax losses, had the effect that no tax was payable on the profits arising in later periods on the reversal of the capital allowances.
The 2006 Act tried to counter that practice by ensuring that an accounting period ends on the sale of a lessor company. The company is treated as receiving income in the accounting period ending on the change of ownership, to the extent that the tax written down value of the assets is less than the accounts value. A deduction of the same amount arises in the next accounting period of the lessee company.
Schedule 31 includes Government proposals to change the 2006 Act, most of which should ensure that the legislation works as intended in all circumstances, including in complex transactions. Schedule 10 to the 2006 Act introduced a charge for lessor companies when sold to recover the tax timing advantage they received from capital allowance claims. That charge was an amount of income introduced by reference to the difference between the balance sheet value of assets owned by the lessor company and their tax written down valuethat is, the amount still eligible for capital allowances. Clearly, if the lessor company did not own the assets, the balance sheet value of assets would be zero.
Lessor companies had been trying to avoid the consequences of schedule 10 to the 2006 Act by entering into sale and leaseback arrangements so that they no longer owned the asset subject to the lease, but could still claim capital allowances. I understand that schedule 31 removes the requirement for the lessor company to own the asset and makes provisions for ascertaining the value of an asset that may not be on the companys balance sheet. The changes apply to all accounting periods that end on or after 22 April 2009, and we support the changes proposed.

Stephen Timms: I, too, bid you a warm welcome to the Chair for our deliberations this afternoon, Mr. Hood. I am grateful to the hon. Member for Hammersmith and Fulham for setting out what the clause does, but let me add a little to what he has said.
The sale of lessor companies legislation, which was introduced Finance Act 2006, prevents a potential loss of tax when a lessor company is sold. It does that by bringing into charge an amount that reflects the difference between the value for capital allowances purposes and the commercial accounting value of assets that the company owns. Where the lessor company is an intermediate lessorone that leases an asset in from one party and leases the same asset out to another partyit may be able to claim capital allowances even though it does not own the assets that it leases out. It therefore benefits from the capital allowances in the same way as a lessor company that owns the assets, but because it does not own the asset, the legislation fails to bring the appropriate amount into charge when the company is sold.
We gather from disclosures under the tax avoidance scheme disclosure rules that groups have entered into sale and leaseback arrangements that turned what was a head lessora company that owned the leased assetinto an intermediate lessor before selling the lessor company. The arrangements made it possible to sell a lessor company without incurring a schedule 10 charge, but the changes we propose will ensure that the legislation captures an appropriate charge even when the lessor company does not own the asset it leases.
The legislation was first published in draft on 13 November 2008, and has been effective from that date. I am pleased to say that HMRC has received no negative representations about it.

Question put and agreed to.

Clause 62 accordingly ordered to stand part of the Bill.

Schedule 31 agreed to.

Clause 63

Leases of plant or machinery

Question proposed, That the clause stand part of the Bill.

Jimmy Hood: With this it will be convenient to discuss the following: that schedule 32 be the Thirty-second schedule to the Bill.

Greg Hands: The clause and schedule relate to long funding leases of plant and machinery and to anti-avoidance. Long funding leases are a special type of lease that, following the Finance Act 2006, break with the traditional rule that the owner of the asset is the person entitled to any capital allowances available in respect of it. Instead, under a long funding lease, the lesseethe person to whom the asset is being leasedhas the right to claim allowances.
The measures in schedule 32 were announced on 13 November 2008, just before the pre-Budget report, and seek to address the following problems, most of which look to us like genuine loophole avoidance and ought to be blocked. The explanatory notes to the clause, particularly the Background Note from paragraph 38 onward, indicate that the measures arise out of disclosure, but give only a broad indication of the problems with key definitions such as that of sale and leaseback.
It is thought that the offending schemes worked along the following lines. First, before 13 November 2008, it was possible for the owner of an asset to sell the right to future rentals from the asset, then grant a long funding finance lease of the asset to a third partyagain, usually a connected party; perhaps another group companyand then take the asset back from that third party on a long funding operating lease under the Finance Act 2006. The combined accounting treatment lead to the owner receiving capital allowances equal to the market value of the asset that he was still using under the operating lease. The mechanics of the scheme seemed to turn on the fact that, by selling the rentals first, the net investment that has to be recognised for accounting purposes at step 2on the grant of the finance leaseis greatly and artificially devalued. However, on taking the asset back under the operating lease, the owner is deemed to incur expenditure equal to the current market value of the assetson the one hand, the value is being depreciated and, on the other hand, the current market value is being used.
Secondly, where an asset had appreciated in value, it could be advantageously sold and leased back under a long funding lease because the sale proceeds could be limited to the unappreciated value. However, the capital allowances under the lease back would accrue to the former owner at the current market value, thereby giving an uplift. Thirdly, before 13 November 2008, at the end of a lease, the asset owner could avoid bringing any disposal value into account if a residual value guarantee agreement was in place. Fourthly, a leasing company that is part of a group could avoid the charge imposed under schedule 10 to the 2006 Act if it wished to leave the group by selling its assets and leasing them back, so that it ceased to own them in that sense for tax purposes. The book value of such a company for schedule 10 purposes was thereby depressed.
Schedule 32 will operate as follows. Paragraphs 1 to 5 prescribe the current market value of the asset to be the disposal value on the grant of a long funding finance lease, thereby targeting steps 1 and 2 of the first scheme that I outlined, as well as the second scheme. The concept of net investment is abolished. Paragraphs 6 to 8 effectively prescribe the disposal value on lease termination for the purposes of calculating the balancing charge, so that a disposal value has to be brought into account regardless of any guarantee arrangement. That will put a stop to the third scheme.
Paragraphs 8 to 11 provide that if the capital payment made on the grant of a long funding lease is brought into account as a disposal value, to the extent that it is so brought into account, it will not bear income tax under section 785C of the Income and Corporation Taxes Act 1988. That appears to be a tidying up exercise that will assist taxpayers. Paragraphs 12 to 14 will prevent the annual investment allowance and first year allowance being claimed by the lessees. Paragraphs 15 to 17 deal with leases made in favour of connected personsproviding a further impediment to the first schemebut they are principally aimed at ensuring that market value is used for schedule 10 purposes where the owner has become lessee of his own assets. Paragraphs 18 and following repeat the exercise for plant and machinery taken on hire purchase agreements. All in all, there is nothing here of great controversy and I can see nothing that the Opposition would oppose.

Stephen Timms: I am grateful to the hon. Gentleman for his explanation and support for the clause. As he said, the schedule introduces legislation to counter avoidance involving the leasing of plant or machineryavoidance that was disclosed to HMRC under the disclosure rules. The schedule also deals with a technical defect in the Capital Allowances Act 2001 that could lead to a loss of tax when a long funding lease ends.
The disclosed schemes involve sale or lease and leaseback that is designed to provide tax relief by way of capital allowances in excess of the net capital cost of the asset to the person entering into the arrangements. As the hon. Gentleman described, arrangements are used that result in the disposal value brought into account for capital allowance purposes being less than the capital allowance relief that can be claimed on reacquisition of the asset under the leaseback. The measure deals with that.
On the technical defect, under the long funding lease rules, a lessee is entitled to claim tax relief for the leased plant or machinery. When the lease ends, an adjustment may be needed to ensure that the total relief is limited to the lessees costs. It became apparent last autumn that if the lease is structured in certain ways, the lessee might obtain relief in excess of their expenditure. The measure ensures that at the end of a long-funding lease, a lessee obtains relief for no more and no less than the amount they paid.
The measure also corrects a minor flaw in the definition of sale and leaseback transactions. It makes small changes that ensure that initial payments under a lease are taxed in full and that ensure consistency with the taxation of chargeable gains.

Greg Hands: The Minister might already have explained this but what is the flaw that has been corrected?

Stephen Timms: I am glad to do so. As the law stands, the sale of plant or machinery followed by a leaseback to someone connected to the other seller who was already leasing the asset does not fall within the existing definitions. This arrangement, although not common, could be used to take sale and leaseback transactions outside the scope of the existing anti-avoidance rules.
The hon. Gentleman referred to the fact that draft legislation was published on 13 November last year. As is normal with anti-avoidance rules, the main provisions will have effect from the date of publication. The amended definitions, the change to the taxation of an initial payment and the amendments to the taxation of chargeable gains rules will apply from 22 April 2009, in line with the Budget date. As well as protecting the Exchequer, early publication allowed time for comments from businesses and their advisers. There has, however, been little comment on the measure; no concerns about any unintended effects have been expressed by businesses. I am grateful for hon. Members support and I ask that the clause and schedule stand part of the Bill.

Question put and agreed to.

Clause 63 accordingly ordered to stand part of the Bill.

Schedule 32 agreed to.

Clause 64

Long funding leases of films

Question proposed, That the clause stand part of the Bill.

Jimmy Hood: With this it will be convenient to discuss the following: that schedule 33 be the Thirty-third schedule to the Bill.

Greg Hands: The clause and schedule are the last in the series of anti-avoidance measures. The provisions relate to long funding leases of films and are designed to target a specific avoidance scheme. The scheme is apparently being used by film-makers who have already claimed capital allowances for the cost of making a film under section 42 of the Finance Act 1992, or section 48 of the Finance (No. 2) Act 1997, or sections 138 to 140 of the Income Tax (Trading and Other Income) Act 2005.
In essence, the scheme, the success of which is disputed by HMRC, appears to have been used in the case of films on existing leases for long periods of, it is generally said, 15 years, at rents which are subject to tax. By terminating the existing lease and replacing it with a long funding finance lease, the tax treatment of the rents is greatly mitigated. Not only that, but there is no recapture by the Revenue of the capital allowances already given. In effect, a film-maker could recover the cost of a film through capital allowances and still enjoy a low tax income.
The provisions of schedule 33 remove that treatment in respect of all long funding finance leases granted after 13 November 2008. There is a degree of retrospection, inasmuch as in the case of a long funding lease granted before that date, the rentals accruing due will receive the new tax treatment, but only for rents falling due after the 13 November cut-off.
Paragraphs 1 to 3 of the schedule exclude the income tax and corporation tax provisions normally applicable to long funding leases, when the subject of the lease is a film and the lease is granted after 13 November 2008. Paragraphs 4 and following exclude those treatments in the case of pre-existing leases that continue to subsist, but only in respect of rents falling due in periods of account commencing on or after 13 November 2008. They include transitional provisions based on time apportionment, where a rental period straddles two periods of account.
We have studied the schedule and find nothing to oppose, but I look forward to hearing whether the Minister agrees with my explanation.

Stephen Timms: The hon. Gentleman is right that the clause introduces schedule 33, which counters avoidance involving the leasing of films. It was introduced in response to information received by HMRC and was announced on 13 November 2008, with draft legislation published at the pre-Budget report. The schedule prevents avoidance that, if unchecked, would have led to a substantial loss of taxperhaps as much as £1.5 billion over 10 or so years.

Greg Hands: This intervention is similar to the one I made this morning. HMRC is rightly trying to recover money that should have been paid. However, the Minister gave some annual figures for two different schemes, then he cited, I think, prospective moneys to be recouped over two or three years, and he has just now given us a figure for a 10-year periodthe significant sum of £1.5 billion. How much of that is likely to be recouped in year 1 of those 10 years?

Stephen Timms: Governments have supported the film industry for a long time. One way in which they have done so is through special reliefs, which have allowed the acquisition costs of a qualifying British film to be written off more quickly by the acquirers for tax purposes. The cost of the film was often recouped by investors through leasing out the film, so that over time the initial tax relief should have been recovered by taxing the rental received under the leases. In practice, most such investment took place via partnerships of wealthy individuals who were able to reduce their taxable income by using the losses generated by the write-off of the cost of the film. The investors received a timing advantage which they would share with the film producers, giving a benefit to the industry.
Those rules were abolished, and in 2007 they were replaced by a relief focused more directly at film producers butthis is the point that the hon. Gentleman has asked aboutmany film partnerships remain. They can last for up to 15 years, so the clause tackles the long-term impact of the avoidance. We estimate the tax at risk to be £90 million for 2009-10, £110 million for next year, £120 million for the following year and £140 million for the year after that. It all adds up, as I have said, to about £1.5 billion over 10 years.
Last November, HMRC became aware of a scheme that was intended to turn the taxable lease rental income into largely untaxed rental income. That would have been achieved by converting the leases into long funding leasesthe hon. Gentleman mentioned thatthe income from which, as a general rule, is largely not brought into account for tax purposes.

Greg Hands: The film industry is extremely important in my constituency: Hammersmith is one of the bases of the UK film industry. The film industry has told me that probably the most important thing is certainty in the tax system. That £1.5 billion seems an awful lot of money to be recouped from anti-avoidance action on film schemes. Has the Minister assessed the likely impact on the UK film industry? How prevalent is the practice with which schedule 33 deals?

Stephen Timms: I think that I can reassure the hon. Gentleman. The special reliefs that gave the initial losses were abolished in 2006. They were replaced by a new relief, which has been in place since January 2007. The measure that we are debating now will therefore have no impact on the new relief, as it relates only to arrangements made before 2006. I reassure the hon. Gentleman on the important point about investment in the British film industry this year and in future years. The measure will have no effect either on previous investments, other than to ensure that the tax that should become payable over time does indeed remain payable. I do not think that there is a problem for the industry, although I take the hon. Gentlemans point about the benefit of certainty.
I am glad that the hon. Gentleman sees nothing to object to, although it may be of interest to the Committee that HMRC has been advised informally that the announcement of the measure last November killed the scheme stone dead before it could be promoted.

Question put and agreed to.

Clause 64 accordingly ordered to stand part of the Bill.

Schedule 33 agreed to.

Clause 65

Real Estate Investment Trusts

Question proposed, That the clause stand part of the Bill.

Jimmy Hood: With this it will be convenient to discuss the following: that schedule 34 be the Thirty-fourth schedule to the Bill.

David Gauke: It is a pleasure to serve under your chairmanship once again, Mr. Hood.
Clause 65 and schedule 34 deal with real estate investment trustsREITs. Those of us who served on the Committee that considered the Bill that became the Finance Act 2006I do not know how many here today had the that pleasure, other than myself and my hon. Friend the Member for Farehamwill recall the legislation that introduced REITs, which came into force in January 2007. REITs were introduced with the intention of allowing investors to make indirect liquid and diversified investments in real estate in a way that attracted a similar tax treatment to direct investment. REITs were important in that they avoided the double taxation experienced by investors in other listed property companies.
Schedule 34 contains provisions relating to the REIT regime, and I have one or two questions for the Minister. If I may, Mr. Hood, I shall take the opportunity to ask about certain aspects of the reform of the REITs regime not included in the schedule, although I appreciate that that issue will be considered in the other place and, indeed, we may return to the REITs regime on Report.
Under paragraphs 3 and 4 of the schedule, REITs can offer convertible, non-voting preference shares in addition to the current categories of permitted investments, such as ordinary share, non-voting preference shares and convertible loan stock. It might help if the Minister were to explain the reasons for that extension.
The Government announced last year that they would stop property-rich groups such as operators of hotels, pubs and retail businesses restructuring and converting to REITs. I understand why the Government did that, but it is clear that the Government are not using schedule 34 to prevent conversion of landlords that let property to pubs, rather than operate them as tied houses. Rent from pubs is to be treated as rental income and not trading income. We have no objection to that liberalisation, but it would be helpful if the Minister explained what representations were made for the change, how many businesses the Government believe will be affected, and why the change has been made, given their steps to prevent property-rich groups from restructuring and converting to REITs.
My main point is an issue on which the Government have received representationsthe requirement for REITS to distribute at least 90 per cent. of their property income annuallyand I know that the British Property Federation raised it. Given the current state of the economy, the housing market and the real estate market more widely, and at a time when credit is not easily available through banks, is it good stewardship to distribute 90 per cent. or more of property income annually, as REITS are required to do? Property companies need cash at the moment, first to strengthen their balance sheets, and secondly because, in the event of an upturn in the property market, which may or may not be imminentI do not want to speculateREITs will want to buy new properties and retaining cash would be helpful to them. In addition, the rental market is weakening, cash flows are under pressure, and REITs may need to build up cash reserves to persuade lenders of their ability to sustain borrowings.
In such circumstances, the Government could take steps, which they have not taken in schedule 34, to provide greater flexibility in the REIT regime. The British Property Federation has suggested three ways in which that could be done. First, distributions paid by a firm could be paid in the form of new sharesstock dividendsand they could count towards the mandatory distribution requirement. Secondly, the mandatory distribution could be deferred by, for example, three years from one year to four years. That would provide REITS with some current flexibility. Thirdly, and perhaps less radical, because breach of the 90 per cent. requirement results in a tax charge and the risk of expulsion from the regimethat is not automatic, but a REIT would be vulnerableperhaps it would be possible, as a short term measure, to consider whether breach of the 90 per cent. requirement could simply result in a tax charge without the risk of expulsion from the regime. The Government have received representations on that, and perhaps the Minister will help by giving the reason for not going down that route. We will consider returning to the matter on Report.
I want to raise a second technical point about REITsthe anti-avoidance provisions relating to interest payments. Property income distributions may be liable to a withholding tax, depending on the recipient, but interest payments tend not to be liable to tax. For that reason, which is a perfectly good one, the PFCRprofit financing cost ratiorule, which is an anti-avoidance provision, prevents REITS from restructuring their arrangements in such a way that distributions are made through interest. We fully understand the need for that, but two points have been raised by the BPF in the context of how that rule may act in a way that was not intended.
First, a REIT might hedge market value movements in debt with a derivative contract. There are perfectly good commercial reasons for doing so: so that a profit or loss involved in repaying debt is matched by a loss or profit in a derivative contract. However, the PFCR does not take account of any profit on debt, but does take account of matching loss on the derivative. Consequently, the loss is counted as a financing cost which may be considerable and cause the REIT to be in breach of the PFCR.
The second circumstance in which the same thing may happen is when market value movements in the debt and the derivatives used to hedge the debt are deferredthe costs involved are deferred until the debt or derivative is repaid or closed out. That can have a distorting effect because all the cost then occurs in one year. It could be that over a period of time a derivative is entered into but the cost all crystallises in one year, which may have a distorting effect in that year. The effect of such distortion is that the REIT may have a penalty charge as a consequence of entering into perfectly sensible hedging arrangements, or of market values moving in a particular way.
I would be grateful to know whether the Government have looked at the definition of financing costs and whether they would consider amending it to address those issues. I appreciate that the Minister has not had notice of all those points, but any light that he can shed on them would be of benefit to the Committee.
A more general question is about the Governments strategic vision for REITs. When they were introduced, there were great hopes that they would take off as a product. That they have not is not to do with failures in the original drafting of the REIT legislation, which schedule 34 seeks to address. These nagging concerns are perfectly reasonable, but there is a concern that the Government are simply not addressing the REITs regime, that it is sitting on the back burner and has not received the focus that it might have.
REITs have clearly worked in encouraging conversion of existing listed commercial property companies. That has happened, but REITs have not attracted new entrants, as was once hoped would happen. I appreciate that this is a difficult time for the property market, but it is also an opportunity. For example, perhaps the best way of addressing banks holdings of unwanted exposure to properties and of finding equity investment would be to create REITs. Indeed, there is some evidence that in the period following a recession, which hopefully we will be in shortly, the equivalent of REITs in countries such as France and Japan tended to prosper. I ask whether we are prepared for that, and whether the Government are showing sufficient flexibility in respect of the REIT regime to benefit from what may be a considerable opportunity.
A point that has been made whenever we have debated REITs, certainly in 2006 and subsequently in various orders where we have amended the regime, is that there is a great opportunity for them to become significant players in the private residential rented sector, and that they could provide professional management that is not always available otherwise. There is an opportunity for greater liquidity for people who want to invest in the private rented market rather than go down the buy-to-let route, particularly given that the reputation of buy to let may well have taken significant damage in recent months. There is an opportunity there for REITs, but it may be necessary to take a more proactive view of the regime.
That is not a criticism of the original regime. However, organisations such as the British Property Federation feel that more could be done to ensure that we have an active and thriving REIT sector in the UK.

Stewart Hosie: The hon. Member for South-West Hertfordshire reminds us of 2006 when the REIT regime was introduced. He will also remember the very strict criteria for the creation of the real estate investment trust. There was a residential criterion, a minimum profit distribution criterion and a criterion that the REIT had to have a full stock exchange listing. The trust could not be a company traded on the alternative investment market or the off-exchange market, and it could not be a private company.
New section 136A(3)(a) states that the regulations may
treat a specified person, or a person in specified circumstances, as forming part of a REIT group.
New section 136A(3)(b) states that the regulations may
provide for a specified provision which applies in respect of members of a REIT group also to apply
to others. I want to ask the Minister whether those others, who have been deemed to form part of a REIT group, would also be obliged to follow the same conditions that have been set up for a REIT proper? I am talking about the size of the company, the stock exchange listing, and so on and so forth. I just want to understand for myself how someone can be deemed to be a REIT or part of a REIT if they do not meet the other conditions that were set out in 2006.
Let me go a little wider and ask the Minister the same question that the hon. Gentleman just asked about the strategic vision for REITs. It was clear at the time, I think, that because there was a requirement for REITs to have a full listing on the stock exchange, they would tend to buy high-yield residential and commercial property and there was less incentive, or almost no incentive, for the small-scale investment trusts to build in the for-profit sector rented accommodation in local areas, which is something that I was very keen to see. I know that the Minister at the time said that that was an issue that would be kept under review.
Will the Minister tell us whether there is an intention to remove some of the restrictions, particularly the full stock exchange listing criterion, to allow smaller entrants into the REIT field? The reason for that would be to provide the core profit for housing in the private rented sector which is so desperately needed. Moreover, it will be very helpful if he can answer my specific question on paragraph 7 on connected persons so I can understand how someone connected to a REIT can be defined as part of a REIT group if they do not meet the original criteria.

Stephen Timms: The origins of the UK real estate investment trust model go back to Kate Barkers review of the housing market, which recommended that there was merit in considering a vehicle that was based on the US REIT model. Such a model has been introduced elsewhere, as the hon. Member for South-West Hertfordshire rightly mentioned, to encourage increased institutional investment in housing. We implemented that proposal and extended its scope to include commercial property. The main objectives of the model, which was launched at the beginning of 2007, was to promote greater efficiency in property investment and to provide smaller-scale investors with access to commercial property returns.
We have seen that the model works well. Some 21 companies so far have announced that they have become UK REITs, including most of the big listed UK property companies. The scheme is still less than three years old, and we expect other companies to join in the future, as investors become more confident in the UK REIT market.
Effectively, the regime removes the tax distortion between investing in property directly and investing in property indirectly by exempting both income and gains made on property from corporation tax provided that the company or the group meets some specified conditions.
We announced in the pre-Budget report that the Bill would amend the conditions to be met by a company or group in the UK real estate investment trust regime to ensure that those conditions could not be circumvented by the artificial creation of new group structures. The conditions include the requirement that at least 75 per cent. of total profits must come from the rental of property to tenants. We confirmed our intention to legislate in the Budget.
Schedule 34, which is introduced by clause 65, amends part 4 of the Finance Act 2006 to introduce a power for the Treasury to make regulations concerning the use of artificial structures to circumvent the existing UK REITs legislation. The regulations, which are available in draft form alongside the clause, are to be made by the affirmative procedure. Regulations to exclude owner-occupied properties from the REITs regime have also been made using existing powers under schedule 6 to the 2006 Act.
Schedule 34 also amends the 2006 Act so that section 98 of the Income and Corporation Taxes Act 1988 is disqualified for companies or groups of companies seeking to join the REITs regime. That will allow a business with tied premisesa pub business, for exampleto treat the rental income from those premises as part of the property rental business of a REIT. Tied premises are those where a company supplies goods to a third party for sale on a premise that the company rents to the third party. Before the amendment, such income would not have been treated as rental income. That created an arbitrary barrier to the REITs regime, which schedule 34 removes.
In addition, following discussions with the industry, schedule 34 makes minor amendments to UK REITs legislation that will have effect on and after 22 April 2009. They address some of the points raised by the British Property Federation, although there are other points that it wishes to promote, a number of which have been mentioned by the hon. Member for South-West Hertfordshire. The minor amendments allow UK REITs to issue an additional type of share; provide a consistent definition of asset; clarify how apportionment of funds between the tax-exempt and non-tax-exempt part of the business should operate; and ensure that the regimes requirements do not create unnecessary barriers to entry.
The hon. Gentleman asked about the extension to convertible preference shares. The extension allows REITs to use such shares where they previously could not, and is made in response to a consultation with the industry. On the general question whether we can do more to help REITs, it is certainly true that UK REITs, along with other parts of the economy, are struggling in the current economic climate. We have announced a wide range of policies to support businesses through what is a difficult period for them and, indeed, for households. The measures will provide help to all parts of the UK economy, and I expect UK REITs to benefit as well. I am less certain that there is a need for very targeted help for UK REITs beyond what we have done to support businesses in general, but we are very happy to listen to representations that people may wish to make to us.

David Gauke: One of the BPFs proposals that I have outlined may involve the deferral of tax revenue, but the other two are likely to be fiscally neutral. Indeed, one of them may raise some revenue. The Government may therefore be able to address the issue without a cost, so I urge the Minister to look at the matter very closely.

Stephen Timms: We will certainly be happy to look at those representations. No amendments have been tabled, but we will, of course, look at proposals.
The hon. Gentleman also asked why we had not relaxed the profit financing cost ratio restriction. The restriction on gearing helps to ensure that profits are available to be distributed in the first place, which helps to protect both the Exchequer and the investor, but we will continue to talk to the BPF on the detail of the profit financing cost ratio. He made the point that stock dividends do not cost anything and asked whether there had not, therefore, been an opportunity for the Government to act. Allowing REITs to issue stock dividends as part of their mandatory income distribution could harm some investors. For instance, any investor who elected to receive cash would see their percentage stake in the company reduced by those electing to receive stock. There is a debate to be had on that proposition.

David Gauke: I acknowledge the Financial Secretarys point, but does he not accept that REITs will have their own incentives to keep investors happy and that the management of a REIT would be careful about pursuing a route that could cause them disadvantage with an investor, because of commercial pressures if nothing else? I acknowledge his concern, but that flexibility would probably not result in the management of a REIT acting recklessly, as far as the interests of investors are concerned.

Stephen Timms: I take the hon. Gentlemans point. My point was simply that there are issues to be weighed when considering a change of that kind, and the effect on investors is one of them. It is not necessarily a showstopper, but it needs to be taken into account.
The hon. Gentleman asked why the Government had not allowed deferral of part of the distribution requirement. It is important to note that each of the conditions of the regime is in place for good reasons. The requirement to distribute 90 per cent. of the profits from the property rental business within 12 months of the end of each accounting period helps to ensure that profits are distributed to shareholders who then pay tax on them, and it also helps to ensure that the investor gets a good deal.
We touched on the use of REITs for residential property investment, but there are difficulties with that in the current economic environment. Doing much about that problem would require significant changes to the regime, and we could then run into some EU state aid difficulties, which is another factor to be borne in mind.

Stewart Hosie: All of the criteria for being a real estate investment trust, such as the profit distribution and the residential qualification, are met, so what EU state aid barrier could there be that would be different for residential property than exists for commercial REITs?

Stephen Timms: The current difficulty is the cost of setting up a REIT for investment in residential property. The model currently works fine for commercial REITs, but there is a cost problem for setting up a REIT for residential investment, and changing that so that is was more attractive for residential investment could lead us into difficulties with EU state aid. The barrier is a cost barrier, but fixing it could cause problems with state aid. Certainly, there would have to be some work to address that.
The hon. Member for Dundee, East asked whether other connected persons would be obliged to follow the REITs conditions. We want the connected person to be part of the existing REIT, rather than a separate REIT, so they would not need to meet all the conditions of the regime. The purpose of that legislation is to prevent a group artificially meeting the requirements of the regime by bringing into the REIT any part of the group that has been artificially removed. I hope that that is helpful and commend the clause and schedule to the Committee.

Question put and agreed to.

Clause 65 accordingly ordered to stand part of the Bill.

Schedule 34 agreed to.

Clause 66

Deductions for employee liabilities

Question proposed, That the clause stand part of the Bill.

David Gauke: I have one brief question on clause 66. It has something in common with clause 67, and our debate will focus on that clause. Both clauses relate to anti-avoidance provisions. The test that is inserted for arrangements that fall foul of those provisions is that
the main purpose... is the avoidance of tax.
Most new avoidance legislation seems to include in its main purpose test the phrase obtaining a tax advantage or something similar. What is the reason for the change in terminology? Is this the terminology that we can expect to see in future in these anti-avoidance provisions and is there not a danger of some complexity or confusion here? The phrase the avoidance of tax seems narrower. I do not know whether that is the intention.

Stephen Timms: Clauses 66 and 67 are an interesting case. Early in the new year, HMRC received information about a particularly abusive avoidance scheme, which relied on deliberate default to generate artificial liabilities, which are then set against the otherwise taxable income of the individual concerned at a potential cost to the Exchequer of about £200 million in the first instance. So on 12 January, to head off this threat to the public finances, I issued a ministerial statement announcing the closure of this scheme with effect from that date.
Following that announcement, HMRC received further information that a variant of the schemethis time involving the legislation on employment-related losseswas being used to similar effect at a potential loss to the public purse of at least £200 million in the first instance. So I took further action on 1 April, but also effective from 12 January, to close this down. We will come to that in the debate on the next clause.
Clause 66 gives effect to the original 12 January statement. It works by amending sections 346 and 555 of the Income Tax (Earnings and Pensions) Act 2003. As they stand, these sections allow relief to employees where either they, or their employer on their behalf, meet the costs of insuring against employment-related liabilities, or the actual cost of those liabilities, such as damages relating to their jobs or legal costs to defend against such damages.
The particular scheme that clause 66 addresses took a rather tortuous route to exploit these provisions and make sure there was no real loss to the scheme users. The arrangements would have involved the use of a number of both companies and trusts, some of them offshore. A key element was the creation of a contrived employment, the duties of which included entering into financial arrangements with another party. During the course of the contrived employment, the individual would deliberately default on some aspects of the financial arrangements. Under the terms of the arrangement, this would trigger automatic damages payable by the individual. The individual would borrow the money to pay the damages, through a loan made by another entity in this rather complex structure, and in reality the individual would not need to repay the loan.
I have gone into that in detail so the Committee has a sense of what we are dealing with and of the degree of contrivance and artificiality.
It is a highly abusive, completely contrived arrangement, with the sole aim of avoiding paying the tax due to the Exchequer. We are providing that that relief be allowed only where there are not arrangements in place designed to avoid tax. Any real employment-related liabilities will still be eligible for relief in the normal way.
The hon. Member for South-West Hertfordshire asked why the main purpose test in the clause uses the phrase
the main purpose...of which is the avoidance of tax.
when most new avoidance legislation uses the tax advantage test, as he rightly said. The main goal is to ensure that all wording is effective in achieving its primary purpose, which we are satisfied that the wording achieves. The words used are in keeping with those used elsewhere, such as the Income Tax (Earnings and Pensions) Act 2003, so they are not novel.
By taking swift action, we are preventing exploitation of the tax system by the schemes of a small number of wealthy people. Honest taxpayers rightly expect the Government to identify such schemes quickly and block them effectively. That is what we have done.

Question put and agreed to.

Clause 66 accordingly ordered to stand part of the Bill.

Clause 67

Employment loss relief

David Gauke: I beg to move amendment 73, in clause 67, page 32, line 6, leave out 12 January and insert 1 April.

Jimmy Hood: With this it will be convenient to discuss amendment 74, in clause 67, page 32, line 7, leave out subsections (3) and (4).

David Gauke: I thank the Financial Secretary for setting out details of the arrangements. He describes them as particularly abusive, which is perfectly accurate given that it is a deliberate default in relation to arrangements entered into during employment to create employment income offsets that can reduce tax on personal income. It is highly contrived. I want to make it clear that we fully support his statement that such loopholes and such contrived and artificial arrangements should be identified quickly and blocked effectively, so we support clauses 66 and 67 in their attempt to do that. We are concerned about the potential retrospective elementI wish to stress that that is a narrow concernwhich is the purpose behind tabling these amendments. I know that we will debate the extent to which it is retrospective later.
This is not the first time that the some of us have debated retrospective taxation. On 22 May last year, I debated the issue with the Financial Secretarys predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy)may I say on behalf of the Opposition that we hope that she is safe and well? A similar point was raised in the context of double taxation treaties and retrospective provisions on Isle of Man partnerships. It would be fair to say that the case against the Government then was stronger than it is today, because then we looked at retrospection going back 21 years for something that HMRC had known about for a long time and not sought to address. One could argue that the arrangements that we debated last year were less abusive then the arrangements that we have today. None the less, there is a principle to do with the nature of retrospective legislation in this field. Last year, the right hon. Member for Liverpool, Wavertree said:
The Government understand some of the concerns about retrospectivity. It is right to be concerned about the use of that, and it is right for the Government to justify every case.[Official Report, Finance Public Bill Committee, 22 May 2008; c. 371-372.]
I therefore make no apology for raising this issue, notwithstanding the aggressive and abusive nature of the loophole that the Government are closing. The point is whether the announcement of 12 January 2009 to which the Financial Secretary referred was sufficient to close the loophole or whether this matter was not addressed effectively until 1 April 2009.
When debating the retrospective nature of taxation, it is customary to refer to the Rees rules, which date back to the Finance Act 1978. The shadow Chief Secretary of the time stated that it is important that clear and specific warning is given prior to a Finance Act implementing any such legislation. My right hon. Friend the Member for Charnwood (Mr. Dorrell) went on in the early 1990s to argue that in addition to those clear and specific warnings being given in advance, there must be exceptional circumstances for legislation to be retrospective. It may well be that the abusive nature of these arrangements and the considerable potential cost to the Exchequer are exceptional circumstances.
I will turn to what the Government said in considering whether the Rees rule was met. In the press release of 12 January 2009, HMRC stated:
The specific avoidance arrangements of which the government is aware aim to exploit the provisions of sections 346 to 348 and 555 to 559 Income Tax (Earnings and Pensions) Act 2003, (ITEPA).
Those references are picked up in clause 66, which we debated earlier. Paragraph 9 of the press release states:
The specific avoidance arrangements being countered are outlined above but the government is aware that it might be possible to use different structures to achieve a similar outcome. As a result the proposed legislation will deny any deduction under section 346 or section 555 ITEPA where the liability in respect of which the deduction would otherwise be due has been paid in connection with arrangements the main purpose, or one of the main purposes, of which is the avoidance of tax.
The press release, which reflects the Financial Secretarys written statement, highlights certain specific arrangements and broadens it further. However, it does not broaden the identification of the scheme used in the loophole as widely as the subsequent press release and technical note of 1 April 2009, to which the Minister referred.
That press release announced further action and was entitled Government taking further action to prevent artificial avoidance schemes. Having outlined the contents of the January provisions, in paragraph 5 the technical note goes on to state:
The Government is aware of a similar scheme or schemes that seek to exploit S11 ITEPA 2003 and S128 ITA 2007.
The essential point is that we are concerned about backdating those anti-avoidance provisions to 12 January, when that announcement addressed certain specific arrangements; indeed it slightly broadened it out to beyond the arrangements of which it was aware, but was not as broad as the 1 April arrangements. We consider that the risks of retrospective legislation are very considerable. That is important as it damages stability and certainty in the UK tax system. If we have a tax system that is unpredictable, it undermines confidence. We are therefore concerned that by backdating the effect of clause 67 to 12 January as opposed to 1 April, the Government are going beyond what we accept as allowable under the Rees rules, the Dorrell doctrine and, indeed, by the statement made by the former Paymaster General, the right hon. Member for Bristol, South (Dawn Primarolo). In December 2004, she referred to remuneration planning, an area where there has been retrospective legislation for some time. This would appear to be broader than that and my attention has been drawn to comments made by the right hon. Lady on 6 June 2006. I interpret her remarks to mean that the approach to remuneration planning applied merely to the extraction from a company of income otherwise taxable in the form that was rendered free of national insurance, PAYE and income tax. I do not think that this is quite what we have here, so we are concerned about these provisions.
Perhaps I can take this opportunity to ask the Minister where the Government stand on retrospectivity in general. In what circumstances do the Government consider that a retrospective provision is justified? Does the Minister recognise that there is a risk that HMRC may use this as a fallback against its mistakes? That was very much the nature of our case last year on partnership income and Isle of Man partnerships. HMRC should have addressed that matter much earlier and it sought to address it through retrospective legislation. What constraints are there on the use of retrospective legislation and do the Government recognise that there are problems caused to the UK tax system if it is overused? It may well be that the Ministers remarks today can provide some reassurance, but it would be a damaging attribute to our tax system if there was frequent use of retrospective legislation in this area.
More specifically, on clause 67 and amendments 73 and 74, may I ask the Minister why the announcement on 12 January was thought to cover more than that which is specifically mentioned in that announcement? I suppose the question that should be asked is why section 11 was not mentioned in it. How does the Minister justify including section 11 in something that was not mentioned for another two and a half months or so? With those questionsI have tried to present this case in a probing mannerI have to warn the Financial Secretary that we may well seek to divide the Committee. We are concerned about this use of retrospective legislation. We are not convinced by what we have heard so far that the Government are fully justified in dating the provisions back to 12 January rather than 1 April, notwithstanding the fact that the Government are absolutely right to seek to close that loophole.

Brian Binley: May I say what a pleasure it is to serve under your chairmanship, Mr. Hood? I am grateful to have the opportunity to speak on the clause, and I congratulate my Front Bench colleagues on emphasising its importance. It seems to me to be one of the most disturbing clauses in the Bill, not least for the wider reasons. My hon. Friend the Member for South-West Hertfordshire made the point that an announcement on certain issues was made on 12 January 2009indeed, I am told that it was made clear that the rules would not apply to payments made after the date of the announcementand the industry ceased to use the scheme. That is the information that I have received.
The crime comes when we consider the announcement of 1 April 2009, when the Government widened the scope of the provision, and did so retrospectively and without notice. It is said that the measure will impact upon only 600 people, but retrospective legislation that impacts upon one person, particularly in such an activity, is not good enough. For 600 people, of course it is not good enough. However, it is the wider questions of perception and the breaking of what many businesses see as a genuine understanding between business and the Department that is the real danger inherent in the provisions.
I understand that the hard-working people of the Treasury are keen to protect the interests of the Government and the nation by stopping tax avoidance. To most people, tax avoidance is unacceptable. I would love to get certain people who live on certain islands and then, through their own newspaper organs, make their own moral judgments, and many Members of the House would agree. In this instance, however, we are not talking about the normal practice of announcing a measure and giving people due warning. We are talking about the Department making an announcement, with no warning, of a measure that would be used retrospectively. Therein lies our concern.
To date, it has been generally accepted practice to apply retrospective tax legislation only when HMRC has announced that it will do so. It is that element that has been broken in the clause. I do not need to tell the Committee that retrospective legislation is bad legislation, no matter what the issue, as it is a fundamental requirement that legal frameworks should provide certainty for individual behaviour at the point when that behaviour takes place and not retrospectively. That is generally accepted as good, fair and proper government. It is the undermining of that concept that is so damaging in the wider sense.
It is the question of perspective that concerns me immensely. I come from a world where certainty is vitalthe business world. I come from a world that believes that treatment between business and the Department is fair and proper. Action of this sort undermines that concept. If it happens more and more, business will begin to think that it cannot trust the Department, and therein lies the real danger. The perception of HMRC itself is under threat when the Government decide to act retrospectively in such a fashion. I recognise that accountants rarely take perception into account, but business men do, because the perception of their business is vital to the well-being of their customers. That is the point that I fear the Treasury is unable to grasp, and which I would particularly like the Minister to address.
The Government tell us that the measure will prevent a loss to the economy of some £200 million. That is pure accountancy talk; it fails to take into account the image of this country doing good and fair business. It is another little brick in that wall that will prevent more and more people from wanting to do business here. What assessment has there been of the impact on people who might want to come to the UK to do business, but might be put off by the thought that they could be taxed retrospectively without their knowledge? That also needs to be taken into account.

Stewart Hosie: I rise to support the Governments attempts to end contrived avoidance schemes. The scheme to which clause 68 is addressed is seriously contrived, and I am sure that when the Minister gets to his feet later, he will have a similar description of the scheme relevant to clause 67. However, I also share the general concerns about retrospectivity. I could have made this argument under any number of the clauses, but I am doing it here because it allows me to raise another matter. I hope that I am not out of order, Mr. Hood, if I engage in a clause stand part debate. I assume that we are taking the amendments and clause stand part together.

Jimmy Hood: I have not made my mind up as to whether we will have a stand part debate, so I suspect that the hon. Gentleman had better make his point now.

Stewart Hosie: I will be as careful as I can, Mr. Hood.
I understood that the practice of those engaged in schemes such as those to which clauses 66 and 67 relate was to notify HMRC shortly after commencement. Was the scheme that the Minister described, and the variation dealt with in clause 67, also notified to HMRC shortly after commencement? That is important.
One thing that we need to do to avoid retrospective taxationthe Bill contains lots of itis to ensure that those working in tax and financial management and planning are able to behave in a proper manner and do not find themselves doing something that their lawyers and advisers tell them is within the law, but which ends up being subject to retrospective legislation days, weeks or even a few months after the commencement of the scheme. That is the point that I wanted to raise in relation to clause 67. Instead of giving post-commencement notification to HMRC, would it not be far better if those engaged in tax and financial planning and management could have pre-commencement approval of schemes, so that they knew that everything they were doing was on the straight and narrow and that they would not then be subject to a large amount of retrospective legislation? Most important, people wishing to use the services of those providing tax and financial planning and advice would then be able to do so with the confidence that they would not fall into schemes that were legal when they handed over the cash, but which ended up being illegal very soon thereafter due to retrospective taxation.
I am sure that I was well wide of the mark, Mr. Hood, but there was no other way I could go. I hope that the Minister will tell us why we do not have pre-commencement approval and why we only have post-commencement notification.

Stephen Timms: As I said, following the action we took in January, we discovered that a highly similar scheme was set up by the same provider, using the same approach and aimed at exactly the same people. The scheme used a loss like that referred to in the clause 66 scheme, which is created by an act of deliberate default during the course of a contrived employment, to exploit the provisions of section 128 of the Income Tax Act 2007. That allows employees to claim loss relief in certain circumstances where that loss arises from the conditions of their employment.
I will run through the measure again. Some of what I say will seem familiar because of the close similarity between the arrangements that clause 66 addresses and the arrangements that clause 67 tackles.
The scheme that clause 67 addresses used a number of entitiescompanies and trusts, some of which may be offshore. A key element is the creation, again, of a contrived employment, the duties of which cover financial arrangements with another party. During the course of the employment, the individual would deliberately default with regard to one or more aspects of the financial arrangements. Under the terms of the arrangement, that would trigger automatic damages payable by the employer that the individual was obliged to share by virtue of their contract of employment. The individual would borrow the money to pay the damages, not through a normal commercial loan from a high street bank or some other lender, but from another entity in the structure. The individual would not in reality repay the loan and, as a result, they would suffer no genuine loss in paying the sum designated as damagesindeed, the only real cost the individual would suffer is the cost of buying entry to the scheme.

David Gauke: I recognise that there is a clear similarity between the section 11 schemes and those schemes identified on 12 January. Does the Financial Secretary also accept that clause 67 will apply to any arrangement that uses section 11 of the Income Tax (Earnings and Pensions) Act 2003, whether it is in relation to an employment loss that arises from a deliberate default or otherwise? I accept that a particular scheme caused HMRC, or the Minister, to make an announcement on 1 April, but the clause is somewhat broader than that and has a retrospective effect. I do not know whether any schemes are caught up as a consequence, but the similarity point is not a clinching argument because the application of clause 67 is broader and applies to schemes that are not quite so similar.

Stephen Timms: I think the similarity is striking. In a moment, I will explain how that affects the argument. I am confident that clause 67 will not damage proper and appropriate uses of the provisions already in legislation. Let me just go a little further.
Despite the arrangements that I have described, the individual would claim that they are entitled to deduct the amount of the damages from their income, because the damages rank as a liability that was incurred when acting in the capacity of an employee.
The general theme of artificial loss creation has been a common feature of tax avoidance for some years, with people wanting to shelter income and gains from tax. A number of previous arrangements around that general theme, but using different parts of tax legislation, have already been closed down. The avoidance that the Government are moving to close down with clause 67 is the individual seeking tax relief against genuine income for a contrived loss that the individual never actually suffered. I acted on 1 April to do that. Because it is a variant on the loophole we closed on 12 January and featured the same individuals, we made it effective from 12 January.
The hon. Member for South-West Hertfordshire asked how targeted clause 67 is. I do not think that it is broadly drawn. The intention is to ensure that it will not be necessary to seek further legislation if more schemes involving claims for loss relief under the 2007 Act are devised. It will also remove any doubt about our view of loss relief claims that are contrived in that way.

David Gauke: Perhaps I am approaching the matter from a different angle, but if the Minister is arguing that there was great similarity, why were section 11 arrangements not picked up on 12 January? Was any consideration given to doing so, or did it come as a surprise to HMRC that there was a way, as the Minister sees it, of achieving the same aim through the other provisions to which we referred?

Stephen Timms: We did not know on 12 January about the device to which the statement of 1 April refers. Information about that arrangement emerged later through a disclosure. I accept that the fine detail of the second scheme is somewhat different from that of the first, but the underlying approach is the same. Both schemes depend on the use of deliberate default to trigger artificial liabilities or losses for which relief would be claimed under legislation intended to provide relief for exceptional circumstances of genuine employment liabilities or losses. The people subscribing to the scheme would have known exactly what they were entering into when they decided to do so.

Jeremy Browne: The Minister is giving a helpful explanation. What is his estimate of the potential cost to the Exchequer were the Government to be defeated on any vote on the clause or the amendments to it?

Stephen Timms: It would be £200 millionprecisely the same as if clause 66 was not included in the Bill, because it deals with the same kind of avoidance targeted at precisely the same people by the same promoter who, having been thwarted by the announcement of 12 January, would, if allowed to do so, have simply switched all their customers into the device that clause 67 addresses.

Jeremy Browne: I assume that the £200 million is an annual figure. If that is the case, is there any expectation that the figure would in time come down, or would others see the opportunity to exploit the same loopholes and, for example, make the aggregate figure over the lifetime of the next Parliament more than £1 billion, rather than just £200 million multiplied by five?

Stephen Timms: We are getting into speculation, but if all those people got away with avoiding £200 million-worth of tax, it is entirely possible that the promoter would find that other people were attracted to use the same device and that the loss would increase.

David Gauke: We are talking about the period from 12 January to 1 April, so we are not talking about ongoing costs. Surely this is a one-off hit. I understand that the Government rightly believe that the scheme was a fraud arrangement anyway and want to avoid the uncertainty.

Stephen Timms: I was asked what would be the cost if clause 67 did not appear in the legislation, and that is the question I answered. A separate question is what would be the loss to the Exchequer if amendments 73 and 74 were agreed. The answer to that is £200 million. That would be a one-off loss.
Amendments 73 and 74 would ensure that clause 67 did not take effect until 1 April. The backdating of the clause was essential to preserve the intent and effect of the January announcement. The scheme, unlike the first, came to our notice through the disclosure regime. It was sufficiently advanced at that point that, had we not backdated the clause, we would have put at risk the entire £200 million protected by the clause and the announcement of 12 January, because all those individuals who had moved to the new variant scheme prior to 1 April would have been able to crystallise the artificial losses to claim against their real taxable income.

Brian Binley: Will the Financial Secretary give way?

Stephen Timms: I will. I was just about to come to the point the hon. Gentleman made in his speech.

Brian Binley: The Financial Secretary has just used the phrase would have put at risk, but what does that actually mean? Does it mean that he is not sure whether it is £200 million at risk or not?

Stephen Timms: There is of course a degree of uncertainty about that, depending upon precisely who had taken advantage of the scheme and made a claim accordingly, but £200 million is our best estimate, soundly based, of the loss to the Exchequer if the backdating had not occurred. The hon. Gentleman said that was disturbing and that about 600 people were involveda figure I had not heard, but he might well have information to which I do not have access on how many are affected. I hope that, on reflection, he would find it far more disturbing if those 600 people, having had their large-scale tax avoidance thwarted by my announcement of 12 January, were able simply to switch across to that other, equally contrived and similar scam and obtain their £200 million between them as a result. That would be much more disturbing than the measure we have announced. I have seen correspondence from the promoters of the scheme rather echoing his points and suggesting that it really was not cricket for the Government to act in that way. I must tell the Committee that, where abusive tax avoidance is being promoted, we will take action to block it and will do so time and again.

Brian Binley: There is nothing at all in the amendment that stops the avoidance process of the scheme the Financial Secretary is talking about. It is simply the concept of the provision being a retrospective reaction to the matter, which has much wider implications than the scheme he is talking about. There are many examples of circumstances in which people in this country feel that others are avoiding tax unfairlyI alluded to one, but there are many others. There is a bigger principle, and that is that HMRC is seen to be acting fairly and decently and not retrospectively, which is not seen as fair and decent in the main. One could still stop the scheme but keep ones honour, and that, too, has relevance.

Stephen Timms: I can certainly reassure the hon. Gentleman that HMRCs action has been fair. He is arguing for bolting the stable door after the horse has bolted, but that would indeed have led to a loss in revenue of £200 million. Had there been no retrospection when closing down the scheme, those 600 people, if that figure is correct, would have been able to make off with that sum. That is unfair. That is what honest taxpayers are worried about. They are worried that people who know exactly what they are doing and are who employ the services of highly paid advisers to devise those ingenious schemes are, by that route, avoiding paying tax like the rest of us.

Mark Todd: I am struggling with a couple of questions for my right hon. Friend. First, what sort of fees must have been payable to those who devised such a contrivance? We must be wondering whether those people deserve our sympathies as widows and orphans seeking relief from the taxpayer. Secondly, does he believe that that type of activity bears any resemblance to the honest business activity referred to by the hon. Member for Northampton, South?

Stephen Timms: My hon. Friend is absolutely right. We are talking about a scam. The people who promoted it know exactly what they are doing and the people who wished to use the scam knew exactly what they were doing. I am sure that he is right and that substantial fees were paid or were due to be paidI do not know how far the payments had gone. One can only surmise that it would have been some proportion of the £200 million. I would suggest that between 5 and 10 per cent. would have been the likely fee, so the promoters stood to gain perhaps £10 million to £20 million from having facilitated a very substantial tax avoidance scam.

Jeremy Browne: Although I share the Ministers view that the scheme is a scam and I would much prefer that the Treasury had the £200 million of additional revenue, particularly in these straitened times for the public finances, would he not agree that the hon. Member for Northampton, South holds his view with great integrity? He should not feel inhibited, and nor should his colleagues, about voting for these amendments merely because Labour Back Benchers choose to describe them in those unfavourable terms.

Stephen Timms: That is a matter for judgment by Opposition Members. We will wait with interest[Interruption.]

Jimmy Hood: Order. I am sure we are all interested in hearing what the Minister has to say, not what each other is saying.

Stephen Timms: Thank you, Mr. Hood. We shall certainly wait with interest to see what Opposition Members decide.
The hon. Member for Northampton, South said that he wants certainty. He can be absolutely certain that when we find out about an abusive scam we will shut it down. Anyone who is interested in participating in such an arrangement can be certain of that. My hon. Friend the Member for South Derbyshire is right such arrangements have nothing whatever to do with the provision of a good and fair business environment in the UK. We are committed to that and everybody knows that we take a very dim view of tax avoidance.
We acted on 1 April to make it clear that the second version of the scheme covered by clause 66 was equally unacceptable. Just like the scheme we closed on 12 January, it relies on abusive and contrived actions over a short period which ignore fiduciary duty to get a tax advantage. It would have been deeply unfair to have allowed that scam to proceed. The Governments response to the second scheme is reasonable and proportionate in the circumstances. There is a degree of retrospection herethat is perfectly correct. I hope that the Committee will accept that that retrospection was justified in the circumstances.
We ensured that all the relevant legal considerations were taken into account, including the Rees rules, the similarities between both schemes, the need to protect the human rights of potential users and previous announcements. In that respect we took account of the announcement on 12 January and the ministerial statement made the following day, as well as the statement made by the then Paymaster General, my right hon. Friend the Member for Bristol, South, on 2 December 2004, which was referred to by the hon. Member for South-West Hertfordshire.

Brian Binley: Will the Minister give way again?

Stephen Timms: Let me just say a couple of words about that statement. My right hon. Friends statement in 2004 warned that where we became aware of arrangements that attempt to frustrate our intention that employers and employees should pay the proper amount of tax, we would introduce legislation to close them down, where necessary from 2 December 2004. It therefore remains the Governments view that in rare cases like this it is appropriate for us to act retrospectively to make sure that abusive schemes are closed down rapidly and effectively. That takes account of the doctrine named after the right hon. Member for Charnwood, who recognised that retrospective legislation should be introduced only in exceptional circumstances and only where the Government consider such action to be necessary to protect the general body of taxpayers. I agree with that view, and this measure is certainly consistent with those criteria. We have met the Rees rules, the Dorrell doctrine and perhaps what we should refer to as the Primarolo doctrine as well.

David Gauke: Try to be more alliterative.

Brian Binley: I shall now try to create the Binley doctrine, with your permission, Mr. Hood. We have a situation in which the Government, rightly and properly, are intent on cutting back on those people who act outside the rules of decency by avoiding tax. The Minister calls such behaviour a scam, which is a bit subjective, bearing in mind that it must have been legal or there would not have been a need for this particular piece of legislation. Can I assume, therefore, that we need many more retrospective pieces of action should similar so-called scams turn up in the future?

Stephen Timms: The hon. Member for South-West Hertfordshire accuses me of failing to achieve consistent alliteration. He is right; I should have referred to the Primarolo principles. I did not entirely understand the question that the hon. Member for Northampton, South asked. If his question is whether we would act similarly again in similar circumstances, the answer is most certainly yes. Anyone who thinks of promoting or taking part in such arrangements needs to understand very clearly that the Government take an extremely dim view of those arrangements and are determined to close them down, as we successfully did in this case.
The hon. Member for Dundee, East asked me about pre-commencement approval. There is provision for that in code of practice 10. Taxpayers can ask about the HMRC view of arrangements before they decide to go ahead with implementing them. That alerts taxpayers to note that HMRC may take action against their proposal. If anyone is in doubt, they can seek clarification.

Stewart Hosie: The Minister said earlier that the scheme that he was talking about had been disclosed. Now he talks about taxpayers being able to check out schemes that they may enter into, and that is all good and well, but can I confirm that promoters are able to seek confirmation of the schemes in advance, or is it only in post-commencement notification that some of the difficulty may arise?

Stephen Timms: Promoters can seek that clearance as well. They are required to disclose, but they can seek clearance if they wish.

David Gauke: Can the Minister tell the Committee the date on which the promoters first started to market the scheme? It appears from what he says, or we can surmise, that it was after 12 January, in the sense that it was an innovation to the scheme that was outlawed on 12 January. At what point was it notified to HMRC? We know that HMRC took action on 1 April, but it might be helpful to the Committee if we knew the other dates.

Stephen Timms: I think that the hon. Gentlemans surmise is correct. It must have been after 12 January and before 1 April. I do not have the precise date in front of me. I am not sure whether we know it. As far as I am aware, the disclosure took place properly, in accordance with the requirements of the rules.
So, this was a completely artificial and contrived arrangement. It was clear to both the promoters and to anyone who was considering taking advantage of the scheme that it was open to abuse. It was essential to backdate the effectiveness of this measure to 12 January. Otherwise, people could have taken advantage of this very big tax avoidance opportunity. I hope that the hon. Gentleman will agree to withdraw his amendments and that the Committee will agree that clause 67 stand part of the Bill.

David Gauke: The Financial Secretary defended the Governments position with much vigour, as we would expect, but I am slightly disappointed in his response. I shall look in general at retrospective legislation in this area before turning to the specific case in front of us, because a balance needs to be achieved between creating certainty within the tax system and the desire that the Minister rightly expresses to close down scams as quickly as possible. As I said earlier, we enthusiastically support the Governments attempts to close down these scams. There is a balance to be achieved; there is a tension.
There is an argument, as the Minister knows, as to whether this scheme falls within the scope of the Primarolo principles. It can be argued, as I did earlier, that that is too narrow to encompass this particular scheme, although I appreciate that there is an alternative view. He is right to say that this scheme is very similar to that identified on 12 January, although as I understand it the 1 April provisions could capture some schemes that are quite dissimilar from those identified on 12 January. He is also right to say, as I acknowledged from the beginning, that this is a particularly abusive scheme, and that there is clearly a substantial cost to the Exchequer.
I am disappointed that we did not get an answer on the Governments general approach to retrospective legislation. As I said earlier, I thought that the legislation that we had in front of us last year was stronger ground to make the case against retrospective legislation than the scheme that we are debating today. In those circumstances, with some concern at the failure of the Government to address the wider issue of retrospectivity, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 67 ordered to stand part of the Bill.

Clause 68 ordered to stand part of the Bill.

Clause 69

Intangible fixed assets and goodwill

Question proposed, That the clause stand part of the Bill.

David Gauke: I have a couple of questions about clause 69, which takes us into the rather arcane and complicated world of the taxation of goodwill and intellectual property. The clause seeks to deny tax relief for deductions derived from the amortisation of goodwill arising and recognised for accounting on the purchase of a business from an unrelated party.
As I understand itI am sure that the Minister will correct me if I am wrongthe perceived mischief that these new provisions aim to thwart is transactions involving the sale of businesses between related parties, with the recognition of goodwill on acquisition by the purchaser. The purchaser would then no doubt claim deductible amortisation for tax purposes by writing down the purchased goodwill. I know that there is a view that the clause is unnecessary because the goodwill would not exist in the accounts or for tax purposes prior to the acquisition; that internally generated goodwill is prohibited by accounting standards and therefore the clause is not necessary.
I would be grateful if the Minister could say why the clause is necessary. It has a particular effect where the transaction involves a purchaser and the seller that are related. Are there concerns that the same mischief could occur between unrelated parties? To reiterate, is the clause really necessary at all? I think that this is one of those cases where the provision is there for the avoidance of doubt. However, if the Minister will elaborate on that point, we shall be grateful.

Stephen Timms: Clause 69 introduces legislation to confirm the tax treatment of goodwill by the corporate intangible fixed asset regime. The rules for the taxation of corporate intangible assets were introduced in the Finance Act 2002 after widespread consultation and they were widely welcomed by businesses. However, some companies acquiring a business carried on prior to 1 April 2002 by a related party have been incorrectly claiming relief for goodwill where none is available.
As the hon. Gentleman was suggesting, that is the reason for changing the rules. The legislation is being clarified to put what HMRC believes to be the correct interpretation of the law beyond doubt, because some people have doubted it. HMRC does not accept that such relief as has been claimed is, in fact, available. The regime treats goodwill of a business carried on by a related party prior to 1 April 2002 as a pre-existing asset. It is brought into the regime only if and when the business is acquired by an unrelated third party.
HMRC will continue to challenge past claims that some companies have tried to make for relief, if necessary through the courts. To complement HMRCs operational response to the problem, the clause confirms that the corporate intangible asset rules function as intended and it aims to put beyond doubt the correct interpretation.
Clause 69 should safeguard up to £2 billion worth of future tax revenue spread over the next 20 years, and I commend it to the Committee.

Question put and agreed to.

Clause 69 accordingly ordered to stand part of the Bill.

Clause 70

Taxable benefit of living accommodation: lease premiums

Stephen Timms: I beg to move amendment 213, in clause 70, page 34, line 24, leave out section 105A and insert sections 105A and 105B.

Jimmy Hood: With this, it will be convenient to discuss Government amendments 214 to 216.

Stephen Timms: The amendments are required to ensure that the full amount of a lease premium, payable in respect of a lease term up to a maximum of 10 years, is spread evenly across the term of the lease for the purposes of calculating the living accommodation benefit in kind charge.
At the Budget, we announced our intention to change the rules for taxing the benefit in kind charge, where employees are provided with living accommodation as a result of their employment, to stop attempts to avoid tax through payment of a lease premium rather than the full market rent for the use of the accommodation.
Clause 70 introduces a rule that means that the value of a lease premium, payable in respect of a lease of 10 years or less, will be taken into account when calculating the benefit in kind charge. The clause contains an anti-avoidance provision to prevent manipulation of the new rules by entering into a lease with an artificial term of more than 10 years and inserting an earlier break clause.
However, in cases involving leases with a break clause that is not exercised, the legislation will not spread the value of the lease premium across the term of the lease. In certain cases, it may not operate to bring the full value of the lease premium into charge in any taxable period.
The Government amendments ensure that the new rules for taxing the living accommodation benefit in kind charge operate as intended to bring into charge the full value of a lease premium and to spread it evenly across the term of the lease. Without the amendments, it would be straightforward to structure a lease premium arrangement in such a way that only a small proportion of the lease premium payable would fall to be taxed under the new rules.

David Gauke: We fully appreciate the thinking behind clause 70 and the amendments that the Financial Secretary explained. We agree that, but for the amendments, it would be relatively easy to avoid the purpose of the clause, but I have a couple of questions. First, what is the cost to the Exchequer of the existing loophole historically and in future? Secondly, will the Financial Secretary explain the reason for 10 years? I realise that there must be a limit, but I would be grateful to know what the thinking was that caused the Government to settle on 10 years as the necessary test.
Living accommodation is a significant cost in bringing internationally mobile employees to the UK, and that goes back to the point that I raised about the saving that will arise from the clause and the amendments. I do not have many comments to make, and I can pick them up on stand part if you are happy with that, Mr. Hood, but if the amount of revenue from additional tax on mainly internationally mobile employees is likely to be substantial in the context of a rise in higher rate income tax, has the Treasury or HMRC assessed what it is likely to be? That raises questions about the overall ability of the UK and specifically the City to attract internationally mobile employees, and whether there is any concern that in some small way the tax burden on them will increase, thus making the UK less attractive to those employees and damaging the competitiveness of the UK and specifically the City. I do not want to make an issue of that, but I would be interested to know whether any assessment has been made.

Stephen Timms: The estimate is that the clause will protect £45 million of revenue in the current year.

David Gauke: I am sorry to intervene before the Financial Secretary has got going. Within that £45 million, does he have any idea of how many individuals will be affected so that we can have an assessment per person?

Stephen Timms: HMRC may well have an estimate, but I do not have it in front of me. If the matter is drawn to my attention, I will certainly let the hon. Gentleman know what it is. He is right about the sort of people about whom we are talking. The truth is that everyone knows what the rules are, and that tax should be paid, but it has become apparent that arrangements are entered into involving a front payment lease premium and a small rent to reduce tax. That arrangement is artificial, and I do not believe that closing the loophole will have a material impact on UK competitiveness.
I think I understood correctly that the hon. Member for South-West Hertfordshire asked about leases of different lengths. When a lease is less than 10 years with a break clause, the same rules apply. When it contains a relevant break clause that is not exercised, the new rules in the amendments will deem that, for the purposes of the legislation, a separate, notional lease had started immediately after the time at which the original lease would have ended had the break clause been exercised. The lease premium payment will be spread across the full terms of the original and notional leases, which would not have been the case under the Bill as drafted. Without the amendments, the total lease premium payment for the full original term of the lease would be spread across the shorter period to the date of the break clause whether or not it was exercised. That is unintended, and the amendments ensure that the new rules apply as intended.
The hon. Gentleman asked about the numbers affected. I cannot give the full number, but the costing was based on 47 cases of individuals employed by 19 companies using those arrangements.

David Gauke: I am grateful for that information, but it suggests a sum of about £1 million per person, which seems extraordinarily high, and I cannot believe that it is right. I do not know whether that is a sample from which the figures were extrapolated, but if we are talking about £1 million per person, it is quite a consideration.

Stephen Timms: My advice is that the costings are based on 47 cases of 19 trusts gaining a tax advantage. They are based on actual cases in which employers have used the lease premium arrangements, and the estimate that I gave does not involve extrapolating from those cases to assume higher levels of tax avoidance. We are indeed discussing some very up-market accommodation.

Amendment 213 agreed to.

Amendments made: 214, in clause 70, page 34, leave out lines 35 to 37 and insert
(d) the net amount payable by P in relation to the lease by way of lease premium is greater than zero..
215, in clause 70, page 34, line 43, leave out from the to end of line 21 on page 35 and insert
net amount payable by P in relation to the lease by way of lease premium.
(3) For provision about the application of this section in relation to certain leases with break clauses, see section 105B.
(4) For the purposes of this section the net amount payable by P in relation to a lease by way of lease premium is
(a) the total amount (if any) that has been paid, or is or will become payable, by P in relation to the lease by way of lease premium, less
(b) any amount within paragraph (a) that has been repaid or is or will become repayable.
(5) In this section and section 105B lease premium means any premium payable
(a) under a lease, or
(b) otherwise under the terms on which a lease is granted.
(6) In the application of this section to Scotland, premium includes a grassum.
105B Lease premiums in the case of leases with break clauses
(1) This section applies to a lease (the original lease) that contains one or more relevant break clauses.
(2) For the purposes of this section
(a) break clause means a provision of a lease that gives a person a right to terminate it so that its term is shorter than it otherwise would be, and
(b) a break clause contained in the original lease is relevant if the right to terminate the lease that it confers is capable of being exercised in such a way that the term of the original lease is 10 years or less.
(3) For the purposes of section 105A
(a) the term of the original lease, and
(b) the net amount payable by P in relation to the lease by way of lease premium,
are to be determined on the assumption that any relevant break clause is exercised in such a way that the term of the lease is as short as possible.
(4) If a relevant break clause is not in fact exercised in such a way that the term of the original lease is as short as possible, the parties to the lease are treated for the purposes of section 105A as if they were parties to another lease (a notional lease) the term of which
(a) begins immediately after the time at which the term of the original lease would have ended, if that break clause had been so exercised, and
(b) ends at the time mentioned in subsection (5).
(5) The term of a notional lease ends
(a) at the time the term of the original lease would end, on the assumption that any relevant break clause that is exercisable only after the beginning of the term of the notional lease is exercised in such a way that the term of the original lease is as short as possible, or
(b) if earlier, the tenth anniversary of the beginning of the term of the original lease.
(6) For the purposes of section 105A, the net amount payable by P in relation to a notional lease by way of lease premium is, in the case of a notional lease the term of which ends under paragraph (a) of subsection (5)
(a) the net amount that would be payable by P in relation to the original lease by way of lease premium on the assumption mentioned in that paragraph, less
(b) any part of that amount that has already been attributed to a period in respect of a lease premium under section 105(4B)(b).
(7) For the purposes of section 105A, the net amount payable by P in relation to a notional lease by way of lease premium is, in the case of notional lease the term of which ends under paragraph (b) of subsection (5), the relevant proportion of
(a) the net amount that would be payable by P in relation to the original lease by way of lease premium, on the assumption that no break clause is exercised, less
(b) any part of that amount that has already been attributed to a period in respect of a lease premium under section 105(4B)(b).
(8) In subsection (7) the relevant proportion means
where
D is the term of the notional lease (in days);
E is the sum of
(a) the term of the notional lease (in days), and
(b) the number of days by which the term of the original lease would exceed 10 years, on the assumption that no break clause is exercised..
216, in clause 70, page 35, line 32, leave out section 105A and insert sections 105A and 105B.(Mr. Timms.)

Clause 70 ordered to stand part of the Bill.

Ordered, That further consideration be now adjourned.[Mr. Blizzard.]

Adjourned till Thursday 18 June at Nine oclock.